A 6.3% Yield From A Strong Utility

Entergy Corporation (NYSE:ETR) is a large regional utilities provider in the southeast United States. The company provides electricity to 2.8 million customers and was founded 100 years ago. The common stock has been roughly flat over the past five years and pays a nice dividend, but in this article, we'll take a look at an alternative way to capitalize on ETR's stable cash flows and that is through owning ETR's debt. We'll take a look at the company's 6% Series First Mortgage Bonds (EMZ) in order to see if they could be a good fit for your portfolio.

To begin, we'll define exactly what EMZ is. EMZ is an exchange-traded debt security which basically means that instead of offering bonds on traditional bond exchanges in large lots of $1,000 or more, EMZ was offered on a stock exchange in increments of $25. This allows not only greater access for smaller investors but also much greater liquidity on the issue than a traditional bond exchange offers. Since it is a debt security it behaves as such; it offers quarterly distributions of interest and doesn't trade in tandem with stocks.

At the issue price of $25 the annualized interest payments on EMZ of $1.50 work out to a 6% coupon. However, the current price of $23.74, a sizable discount to the issue price, means the $1.50 in dividends works out to a current yield of 6.3%. While you can certainly find higher yielding issues than this, the combination of ETR's financial strength and stability means EMZ, in my view, is a very safe income investment vehicle that can let you collect large interest payments and still sleep at night.

Since EMZ is a debt issue and not a preferred stock it does have a stated maturity date. In this case, the bonds mature in 2051. While I understand this is likely too long of a duration for most investors since EMZ is exchange-traded, it is very easy for one to move in and out of EMZ as needed. Any issue that has a maturity date of 20+ years is going to have interest rate and maturity risk, but if you don't intend to hold until maturity anyway, EMZ can still be a great option. And as a side note, ETR has the option to call this issue beginning in May of 2016 at the full issue price of $25. Whether this will happen or not is anyone's guess but if it does, the discount to the call price of $1.26 per share means that if it is called, holders will be made whole plus a decent premium for their trouble.

Unfortunately, since distributions from EMZ are interest and not dividends, they are not eligible for the preferential dividend tax treatment. This means that holders of EMZ in a taxable account would be subject to a much lower after-tax yield than a similar preferred stock issue that was eligible for the preferential treatment. If you hold EMZ in a taxable account it shouldn't matter, but for those seeking current income, depending on your tax situation, it could be a sizable negative.

There are some risks to owning EMZ although I find them to be somewhat muted in comparison to other income investment vehicles. First and foremost is interest rate risk. Any interest-bearing security is going to be subject to interest rates moving up and down, and if we see interest rates spike, EMZ will likely suffer capital losses. This risk is inherent in owning income securities and EMZ is certainly not immune from that. In addition, the long maturity can be off-putting for some investors as no one knows what the world will look like in 38 years and whether ETR will even exist. However, as EMZ is exchange-traded, it is easy to get in and out so when the time comes, you can simply unload your position in EMZ.

Astute investors will notice that the current yield of EMZ is only around 100 basis points higher than ETR's common stock and may wonder why anyone would choose EMZ over simply purchasing the common shares. For me, income investments shouldn't be subject to the potential capital losses inherent in owning common stocks. While ETR and other utilities are generally less volatile than the broader market, the fact is that if there is a selloff in the wider stock market, ETR is going down as well regardless of its particular situation. I find that exchange-traded debt and preferred securities, particularly ones from high quality payers like ETR, offer high levels of income but without the potential volatility the stock market brings.

EMZ is not for everyone but it does represent a great opportunity to grab a very safe 6.3% yield from a strong, stable payer. You can certainly own the common of ETR and still get a nice yield, but you are subjecting yourself to stock market risk separate from the company-specific risks of ETR. And while EMZ may not be right for certain taxable account holders, holders in a retirement account can benefit from the stable payer and large current yield for years to come.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.